Educational Articles

Coverage Initiation: SolarCity

Paul E. Debbas, CFA
| September 23, 2013

Value Line has initiated coverage of SolarCity (SCTY) in its flagship product, The Value Line Investment Survey. The company was founded in 2006. As the name suggests, SolarCity provides solar energy to homeowners, businesses, and institutions such as schools and governments. The company serves more than 68,000 customers in 14 states (plus Washington, DC) with 29 operations centers. SolarCity has more than 3,300 employees and is headquartered in San Mateo, California. Its stock began trading on NASDAQ in December of 2012.

SolarCity’s business model is based on signing 20-year agreements (transferrable upon moving) with customers that are billed monthly, similar to how a utility bills its ratepayers. The customer reduces its electric bills without incurring an up-front cost of installation. SolarCity handles all aspects of each project, including financing, engineering, installation, monitoring and maintenance, and offering complementary products and services. Proprietary software helps in this regard. About 55% of the company’s contracts are leases based on fixed monthly payments, and 45% are purchased-power agreements that are variable, based on production. SolarCity offers other services such as home energy evaluations and electric vehicle charging equipment.

In addition to the use of its own sales force, SolarCity is trying to win business through partnerships with other companies. The company has a presence in more than 450 Home Depot (HD - Free Home Depot Stock Report) stores. It has entered into partnerships with homebuilders such as PulteGroup (PHM) and Toll Brothers (TOL).

SolarCity has plenty of room for growth. Market penetration of solar energy is low. Although not every part of the United States is well-suited for solar energy, the company can enter other states. International expansion is possible, too. Forming additional partnerships is another means of growth. In September, SolarCity signed an agreement with Direct Energy, a retail energy marketer, which will enable the company to provide solar power to Direct Energy’s business customers. SolarCity looks for acquisitions, too. Also in September, it paid $120 million in cash and stock for Paramount Solar.

As SolarCity grows, operating leverage reduces its cost per unit. However, the company is losing money, and the year-to-year deficit rose in the first six months of 2013. (A huge increase in average shares outstanding made the per-share loss significantly smaller, however.) In fact, its sales and marketing costs alone—without even including general and administrative expenses—exceed its gross profit. Not surprisingly, SolarCity pays no dividend. The balance sheet has a moderate amount of debt.

Investors should be aware of some risk factors. The solar industry relies on investment tax credits and other government subsidies, so if these are reduced or eliminated, that would hurt SolarCity. Most states’ regulatory policy includes “net metering,” in which solar customers are connected to the electric grid and can receive credit for the solar energy that they produce but do not consume. Thus, any limits on net metering would hurt the solar industry. This industry is highly competitive, and numerous other companies can provide solar energy to customers that want it. SolarCity believes that its vertical integration provides a competitive advantage over companies that just offer financing or installation.

This equity is suitable only for risk-tolerant investors. The ongoing operating losses are one reason. In addition, this stock has shown volatility in its short trading history. Since SolarCity had its initial public offering in December of 2012 at $8 a share, the stock price has reached as high as $52.77 before falling back. Lately, the quotation has usually been in a range of $30 to $40.

For a more thorough look at SolarCity’s business prospects, and the particular investment merits of its stock, subscribers should examine our full report in The Value Line Investment Survey.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.